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10 things about the new revenue standard: Round 3

Scott Taub | July 12, 2016

It’s been just over two years since the Financial Accounting Standards Board issued its new standard on revenue recognition. Shortly thereafter, I wrote a column providing 10 quick thoughts on the new standard. After a year of working with the new standard, I provided 10 more thoughts. It’s time, then, for one more round on Topic 606, building on what I’ve learned in the past year consulting with clients on applying the new guidance, participating in discussions of the FASB/IASB Joint Transition Resource Group for Revenue Recognition, and writing a book on the topic.

If you’re not yet working on it, get started. There’s still about 17 months before calendar-year public companies are required to adopt Topic 606. While that seems like a long time, the scope and breadth of this new standard is greater than anything else that’s come out in decades.

Accounting firms and professional organizations continually ask for feedback on where companies are in preparation for the new standard. As recently as last month, 20 to 25 percent of participants in a webinar that I presented reported that they hadn’t yet really started their implementation efforts. And this was from people who had taken the time to attend a webinar on the topic.

If your changes aren’t significant, you still have enough time to study and adopt the provisions of Topic 606—even if you haven’t started yet. But for those who start studying the new standard later this year and realize there are significant changes, it might be quite difficult to prepare for those changes in time. It’s time to get started in earnest.

Recent amendments have made things easier.  There have been three recent amendments to Topic 606, covering a variety of topics. While most of the items addressed were narrow, several were more significant and pervasive. In every case, though, the changes make the standard easier to adopt. In fact, every change falls into one (or both) of two buckets:

  1. Clarifications of principles so that the chance of misunderstanding is reduced.
  2. Changes to make the standard more operational, either through the addition of exceptions or options, or by easing difficult judgments.

In no case did FASB significantly change the accounting requirements with these amendments, and in no case do the amendments increase the cost or complexity of implementing Topic 606. While I don’t agree with all of them, there is no question that all the changes are in the direction of making it easier to do the required accounting.

If you’re not yet working on it, get started. There’s still about 17 months before calendar-year public companies are required to adopt Topic 606. While that seems like a long time, the scope and breadth of this new standard is greater than anything else that’s come out in decades.

No further amendments are likely. Except for a small (but potentially significant) proposed amendment to ease a disclosure requirement, there aren’t likely to be any further amendments before the effective date. The TRG has considered questions in every major area of the standard already, and it is unlikely that additional questions will evidence a need for further changes.

The SEC staff can help. Some companies will come upon implementation issues that are fact-specific and very important to the financial statements. Such matters probably don’t make good fodder for a TRG discussion, but they can be discussed with the SEC staff ahead of adoption of Topic 606. The thought of voluntarily bringing an accounting issue to the attention of the SEC staff may be a scary one, but the staff has a long-standing process on handling such inquiries and considers them a routine part of the SEC’s mission. The “pre-clearance” process is fairly straightforward, and there is guidance on the SEC’s website. If you want to be confident that your application of Topic 606 to your fact pattern is acceptable, this is your best path.

Some questions aren’t being raised. While the TRG has addressed over 50 issues, there are some application questions that have been identified that have not yet been sent to the TRG or FASB staff. Instead, industry groups continue to mull the questions over. Some believe that part of the reason for the delay is fear that the TRG will not be supportive of the industry’s preferred treatment, and a belief that “It is better to beg forgiveness than ask permission.” On the other hand, the delay might simply be related to gathering facts and preparing a detailed white paper. Whatever the reason, further delay is a poor strategy.

Finding out now that your preferred view may not be acceptable is relatively painless compared to what will happen if you find out in 2020. The SEC and FASB staff are well aware that known issues are not being submitted and aren’t likely to be sympathetic when the issues are finally raised after adoption (e.g., after SEC staff comments). An opportunity to improve consistency and reduce the risk the risk of restatements will be lost if the questions aren’t raised soon.

Don’t forget disclosures. It‘s understandable that work to adopt a new accounting standard is primarily focused on making sure the balance sheet and income statement correctly reflect the new guidance. Footnote disclosures are often a last-minute thing. In this case, however, it is important to consider disclosures earlier.

In part because disclosure requirements under existing revenue standards are so poor, FASB and the IASB considered disclosures carefully in the revenue project, going so far as to meet with groups of analysts and companies solely to discuss disclosures. The result is a set of disclosure requirements that mandate a significant amount of information, much of it quantitative. If you wait until you begin preparing the financial statements to think about disclosures, you may find that the information you need isn’t readily available.

Document judgments. Adopting this standard is likely to require judgments in a number of areas, due in large part to the principles-based nature of the standard. Gone are many current rules that essentially say “If you have to ask, don’t book the revenue.” Instead, professional judgment will be needed to determine how certain principles apply to particular facts. It is important to document judgments and conclusions as you make them. The best response to any question that might arise down the road as to why you’re applying the guidance in a particular way is the documentation you prepared when first considering the matter. Don’t skip this critical step and leave yourself open to misunderstandings in the future.

For many, this goes beyond financial reporting. Another reason to get started on understanding the implications of the new standard is that there is a good chance that you will need to think about more than just the financial statement impact. For example:

  • Compensation arrangements could be affected, particularly sales commissions. Companies will need to determine whether changes in revenue recognition should affect when commissions are paid.
  • Particularly in industries with specialized guidance under current revenue literature, like software and real estate, a minor promise could have a major effect on revenue recognition. Some companies have used these fairly strict rules on revenue recognition as a base for policies regarding what types of promises may be made to customers. With those strict rules going away under Topic 606, these companies will need to decide whether and how their policies should change.
  • Changes in revenue recognition may affect measures used in debt covenants, potentially necessitating changes in compliance benchmarks. Alternatively, some debt agreements specify that measures will be calculated based on accounting principles in place at the time the borrowing agreement was signed. Such agreements need to be amended to avoid the necessity of keeping records under both old and new standards.

Of course, plenty of other parts of the business may be affected as well, and companies will need to plan for sufficient lead time to make whatever changes are necessary.

Pre-adoption disclosures have been abysmal. The SEC requires disclosures about new accounting standards that have not yet been adopted. Almost uniformly, companies have so far disclosed nothing except the existence of the new standard and the fact that they are evaluating its effects. That’s not helpful. Even without having completed the analysis, potential items for disclosure include:

  • Identification of portions of the business where changes in accounting are more or less likely.
  • For areas where changes are more likely, the potential direction of those changes (i.e., faster or slower revenue recognition).
  • Explanation of what is being done to assess the effect of the new standard.
  • Whether debt covenants or business processes may be affected, and what the company is doing to address those issues.

Of course, as determinations are made regarding policies that will change, and policies that will not need to change, disclosure should be made of those conclusions, even if the magnitude of any changes can’t be quantified and even if additional items are still to be assessed. Hopefully, disclosures in balance amounts of this year will begin to include actual substance.

There won’t be another delay. I’ve heard some suggest that because FASB just finalized changes to Topic 606 in the past few months, another delay in the mandatory adoption date is justified. Not gonna happen. As I noted above, the recent changes made compliance with the standard easier. Those amendments could only shorten the time needed to adopt, not increase it. Only a company that had implemented a strategy of waiting until the amendments were out to start implementation work could now be caught in a time-crunch, and neither FASB nor the SEC has much sympathy for that.

So, circling back to point number 1 in this column, it’s time to get to work on adopting this thing.